The Whitnell Way

Insights For Business Owners, Executives And Affluent Families

When The Markets Throw You Lemons, Make Lemonade

Strategies To Take Advantage Of Today’s Opportunities

Lately I’ve been meeting with clients over luncheons. I hear the concern in my clients’ voices during these conversations. Let’s be honest. The markets have been rough for quite some time now. This could last a while and no one can really say when things will improve. But I want to provide a perspective here that I think might help you see things in a different light.

It wasn’t that long ago that we were facing a much more difficult market. The downturn of 2007 and 2008 are still fresh in the minds of many affluent investors. But people often seem to forget the very substantial recovery that followed. Funny isn’t it? We remember the pain of the losses, but so quickly seem to forget the joys of a rebounding market.

The clients who took my advice during the downturn of 2007 and 2008 prepared themselves for a financial opportunity that only rarely comes around. After 2008, for nearly 7 years, we saw the markets climb consistently. They tasted the sour lemons of 2007 and 2008 and turned that into sweet lemonade.

Stated a different way: I believe major market corrections provide opportunities for people who are prepared to take a long-term perspective and make the kinds of investments that will pay off in years to come. How do you do this? Here are my perspectives.

"I take great pleasure in helping my clients find better and more tax efficient ways to pass their wealth on to the ones they love and the charities about which they are passionate."

Why now is a good time to take action

A moment ago I described the luncheons I am having with clients these days. Nearly all of my clients express concerns in these meetings about what might happen to their wealth. But somewhere in the middle of the conversation, the tenor shifts.

Clients who have been with me for many years understand the risk of selling during a near panic down cycle. I have pointed out a number of studies that show that most investors sell when markets are falling. They wait for things to “get better” and then buy when markets are rising. This means people generally buy high and sell low, a recipe for financial loss.

I believe global stocks are on sale right now. Many sectors of the global stock market have fallen much farther than the S&P 500. Buying quality assets when they are out of favor enhances opportunity for future growth and puts you in a better stance of buying low. Is this strategy right for your family?

Who should, and should not, take action now

I want to be clear about something. I am not saying that every investor should try the strategies I’m about to recommend. That may not make sense. But there are certain types of situations that lend themselves to these strategies.

People who have adequate income or liquidity to maintain their lifestyle for the next year or two, without needing to sell assets, should consider investing any excess liquidity now. Those who may need to sell stocks to cover living expenses should not be buying more stocks now or at any period of time for that matter. Markets are too unpredictable to do that.

This will require you to make an analysis of your cash-flow requirements for the next several years. If you are confident that you won’t need the cash for basic expenses, then you might consider these strategies to take advantage of this market opportunity.

The strategies I’m about to recommend are for people with a long-term perspective. Clients ask me “what do you mean by long term?” Here is how I answer that.

My clients who benefitted from taking advantage of the 60% stock market drop from the fall of 2007 to March of 2009 may or may not find it appropriate to do that again. They are 7 years older and their vision of what “long term” means has changed. Age is a factor. Clients whose time horizon has shortened should be more risk averse unless they view the management of their portfolios as managing the legacy for their heirs.

How to take advantage of this market – wealth transfer

Most of my clients have substantial net worth. So here is an idea to help transfer some of that wealth in a tax-efficient manner, given today’s economic climate, to heirs and loved ones.

Consider setting up a gift fund for your children or grandchildren now. This is a great time to transfer wealth, when the value of particular investments is down. This mitigates a lot of taxes you would otherwise have to pay when the markets recover.

The maximum gift you can make today is $14,000 without paying taxes on it, according to the annual exclusionary gift tax. Many of the companies in the S&P are down by 20% or more. If you own stock in one of these companies, now might a good time to transfer it to loved ones. Why?

Let’s assume you own stock in a company that has been valued at $20 per share and you own 1,000 shares. Let’s assume that stock has dropped to $14 per share. The total current value of the stock is $14,000. Now you can give those 1,000 shares to a loved one and be below the annual exclusionary gift tax.

You can give the entire amount without paying any taxes on it. If this stock recovers back to $20 a share, you will have given a gift of $20,000 but with no tax burden on the transfer.

This strategy works even better for larger gifts. Special gift trusts exist that allow people to transfer large amounts of wealth to family members without causing a taxable gift.

For example, let’s assume that you have $2 million of stock that has fallen to $1.4 million. You transfer that stock into a two-year trust. At the end of the two years, you need to take back $1.4 million of value plus a modest amount of interest (less than $50,000).

If the stock recovers to its $2 million value, you will have been able to transfer over a half a million dollars of value that is not treated as a gift. This strategy is extremely popular for families with large wealth who want to transfer much of it to their heirs tax free. Under current law, only a couple’s estate that exceeds about $11 million will be subject to federal estate tax.

How to take advantage of this market – Roth Conversion

Many people who did Roth conversions after 2007 and 2008 saw the value of those accounts double or even triple during the recovery. I advised several of my clients to do this and it worked out well for them.

But the best news is that all of the taxes were paid as the funds were converted to the Roth accounts. So the growth in principal was essentially tax free. The dividends that accumulate in the account are also tax-free.

Is this right for you? It can actually feel pretty ugly at the start. Here is what I mean.

This strategy requires you to pay taxes at a time when you feel least likely to be able to pay taxes. If you can stomach this feeling, the long-term benefits to you could be very attractive.

Here is how you do this. Let’s assume you have a $100,000 IRA account that is now down to $50,000 in value. You convert the $50,000 to a Roth account which requires you to claim this on your taxes as income. That’s the ouch part of this.

Let’s assume that over the next few years the stock recovers back to it’s $100,000 value. It also paid $10,000 in dividends so your new Roth balance is $110,000. At whatever time you decide to withdraw the money, you’ll pay no additional tax on it. Or you can allow the account to grow and both the original $110,000 plus any incremental growth will never be taxable either for you or for your spouse or your heirs.

Here is something else to bear in mind. An IRA account requires you to start taking distributions at 70.5 years of age. There are no such restrictions for Roth accounts. You can allow these to grow, without taking distributions, for the rest of your life and your spouse’s life. If you leave it to your children or grandchildren, they will be required to take the money out during their lifetime, but all of the distributions will be tax free to them.

This is a great long-term strategy for those who have a vision for the future.

What to do next

Don’t have a short memory. The period of 2007-2008 left a lot of people with panic. I helped guide my clients toward finding great buys that grew substantially in value, some even tripling in value, in the years following the great recession.

When clients say to me, “we lost money in the recession,” I say – “what do you mean you lost money? Every day your stock goes up or goes down. The only way you lose is if you sell it at a loss. If you don’t sell and it recovers, you’re just delaying the recognition of your profit. By selling, you’re eliminating the possibility of realizing a profit.”

If you’d like to explore how the strategies I’ve described here might apply to your unique situation, let’s have a conversation.

The information contained in this article is provided for informational purposes only. No illustration or content in it should be construed as a substitute for informed professional tax, legal, and/or financial advice.